It is rare for a middle market construction company to have company-wide visibility into cash flow in a way that enables them to proactively manage and maximize cash flow. This can result in companies running low on funds, which can damage relationships with the companies’ lender and bonding agent. And in some cases, it may require owners to inject additional cash into the operation.
Fortunately, there is a solution. By making a few simple changes, middle market construction companies can actively maximize cash flow, become more agile, and gain a better understanding of expected cash and debt levels. And in the process, unlock millions in cash.
The first step is to establish clear working capital metrics and KPIs (key performance indicators) that carefully track both billing and receipt of accounts receivable and accounts payable.
Next, create a close collaboration between project managers and the finance teams. The finance group should be trained on how to work with project managers, so they understand when and how to submit pay applications and the corresponding invoices for each project.
It is also important for the finance team to understand the terms of the project contracts. Too often the accounts receivable team is not fully aware of the terms on a project contract and the team may have to submit pay applications multiple times before they are accepted. This can cause significant delays in invoicing, create problematic “underbilling” situations, and delay the ultimate collection of accounts receivable.
After a project is underway and milestones are set, there are several actions finance teams can take to maximize cash flow, and the first is to submit correct pay applications in a timely manner that are accepted by the client.
Typically, construction companies have a brief window in which they can submit a pay application to their customer—often within five days of month close. So, it is essential that the pay applications be correct and timely to facilitate prompt invoicing. Otherwise, you are left waiting for another month or more until the next window opens.
Once a collaboration between finance and project managers has been established, the two teams should work together to structure contracts that allow for better billing terms. The goal should be to bill appropriate amounts early in the project once certain milestones are hit, so any costs related to materials, machinery, and equipment needed for the job are covered. Contracts should be structured for the company to be paid in a timely fashion for all project-related expenditures.
Another common mistake of finance teams in the construction industry is the failure to follow up on overdue invoices. The delayed receipt of cash places an unnecessary burden on the company because accounts payable is still writing checks despite the fact that accounts receivable is not collecting them.
An A/R aging report should be prepared and monitored closely, and accounts receivable agings should be reviewed at least on a weekly basis. If invoices are not being paid on time, finance teams should follow up with customers in a constructive, timely manner to ensure that payments are made and received on time.
By following these steps, middle market construction companies will not only unlock millions in cash, but they can gain visibility into future financial performance, which helps to deliver on promises to finance institutions.
The construction industry consultants at FortéOne have over 20 years’ experience building and leading construction companies and understand how to install best practices that maximize profitability.